Making 401(k) Plans The Foundation Of Old-Age Income Is A Joke

Making self-directed retirement savings plans like the 401(k) the
foundation of old-age income is as economically inefficient as
making pins one at a time.

Specialization makes for economic efficiency. We do not all know
how to wire our homes for electricity or plumb them to carry
fresh water in and wastewater out without spilling a drop. Using
self-directed investment through 401(k)-type plans is the
economic equivalent of expecting every worker to be her own
roofer and surgeon.

Most people lack the necessary time, knowledge and highly
specialized skills to manage investments and time in order to
accumulate enough wealth to sustain them from the day they stop
working until they die. The result of creating a population of
financial do-it-yourselfers is proving to be shocking and
painful, leaving people worse off than need be.

Look at it this way: if investing was something just anybody can
do, the average job on Wall Street would pay average wages. But
stockbrokers, investment advisers and others who become expert at
subtle concepts like the time value of money, asset allocation
and risk and opportunity costs make more than most people because
those skills add value by reducing inefficiency and increasing
returns.

The Labor Department publishes data going back to 1989 comparing
investment returns of traditional pensions and 401(k) plans
through 2008. The professional managers of traditional pensions
performed better than individuals in their 401(k) plans in
fifteen of twenty years. In every year when the stock market was
down, the pension plans lost less than the 401(k) plans, numbers
that reflect the steady hand of professional money managers as
opposed to the less informed and sometimes panicked hands of
individual amateur investors.

In 2008, when the stock market fell sharply, pension plans lost
almost 20 percent of their value, but 401(k) plans lost 24.9
percent. That means that for every dollar pension plans lost, the
401(k) plans lost $1.25. Recovering from those losses will be a
lot harder for 401(k) savers than those denied their benefit
pension plans.

Steve Butler, a San Francisco Bay Area financial adviser who
calls himself “Mr. 401k,” praises 401(k) plans—if the costs are
held down through smart shopping by the employer. His studies
show that many workers pay one percentage point a year more in
costs than necessary because their employers chose high-cost
plans.

Again, a single percentage point may not seem like much but, over
time, it adds up to a lot. Consider what happens if you put
$1,000 in a 401(k) annually for forty years and earn 5 percent a
year instead of 4 percent. After forty years, earning 5 percent
annually would yield more than $181,000, but the other account
would hold less than $137,000. That one percentage point a year
of extra fees robs you of a third of your 401(k) savings at
retirement.

Employers also shortchange workers by paying them with debased
currency. It’s an old trick, dating at least to the sixteenth
century, according to David Hackett Fischer, the Brandeis
University historian, in his book The Great Wave. In that
era, Fischer tells us, the merchants of Venice and Florence got
laws passed “that allowed them to insist on being paid in gold l
orins or ducats, which held their value, but permitted them
to pay wages and taxes in silver coins, which were much
debased.” The result?

“As a consequence rich merchants grew richer and the poor sank
deeper into misery and degradation."

Excerpted from THE FINE PRINT: How Big Companies Use “Plain
English” to Rob You Blind. Published by Portfolio/Penguin.
Copyright (c) David Cay Johnston, 2012.